Should I Invest in Self-Storage?

Residential property investing is the most simple and understandable for many investors making their initial forays into the real estate market. After all, the majority of people have rented out or bought a home at some point in their lives. They are aware of how residential structures work.

However, a residential-only mindset could let an investor miss out on other, more lucrative prospects. Self-storage is one of those chances; it's a booming asset class with an estimated $48 billion in market value and rising.

In this post, we give an introduction to the self-storage market and go over key advantages and disadvantages that investors should think about when evaluating a self-storage potential. Learn more by reading on.

What Is Self-Storage?

Simply described, a self-storage facility is an area that can be rented out to outside parties to use as secure, convenient storage for their goods. This space is typically divided into many units.

There is a great need for self-storage. Self-storage is used by people for a wide range of reasons, such as to complement their current storage, to store belongings during home renovations, for archiving and decluttering needs, during different life transitions, and when they are moving.

Self-storage is often divided into the following three "classes":

Class A self-storage: These facilities are the most expensive, offer the most up-to-date amenities (such as climate control), are professionally maintained, and have recently been built (within 10 to 15 years). They also often have low vacancy rates. Class A self-storage is conveniently located and frequently paired with similar businesses like UPS or U-Haul rentals.
Class B self-storage: These facilities are older (often over 15 years old), well-maintained, but may not have 24/7 on-site management. They also offer fewer amenities and, in general, charge low- and middle-income renters average rates. These homes will typically be close to major thoroughfares, though not always in desirable areas.
Class C storage facilities: these tend to be older, in less convenient locations (typically off the beaten path), with few or no amenities, and with insufficient security. In order to provide investors with a reasonable return, these properties frequently have the lowest rent and may need considerable property upgrades.
There isn't a "best" or "worst" self-storage class. Depending on an investor's risk tolerance and planned business plan, any one could be a profitable investment. Over time, a value-add focused self-storage sponsor can frequently bring Class B/C properties up to par with Class A facilities.

The Self-Storage Industry's History

Over the past 50 years, the self-storage market has undergone significant transformation, notably in terms of the layout and quality of services offered by these facilities. Self-storage facilities were once plain, lengthy warehouses with sporadically located garage doors leading to partitioned areas where people would store their goods. There may or may not be a fence around the property, but security at these places was often not very strong.

Self-storage structures were frequently designated for oddly shaped parcels of land or other abandoned pieces of property that people struggled to develop for other purposes. They served as the last-ditch development when no other plans could be made to make money.

Rewind to the present day. The self-storage sector is not just a side gig. It's a desirable asset class right now. Self-storage facilities are no longer hidden on remote properties. Self-storage facilities are now found in well-known cities, next to popular establishments like supermarkets and big-box retailers.

The value of self-storage facilities has also increased as a result of their modernization. Self-storage facilities of today are frequently multi-story structures with variously sized climate-controlled units. They have strong security measures, such as automatic gates. Many are combined with related services, including U-Haul trucking facilities, to give people looking to relocate and subsequently store their belongings a one-stop shop.


The Benefits and Drawbacks of Self-Storage Real Estate Investing

Investor interest in self-storage is beginning to grow at an unprecedented rate because to historically low interest rates and the asset's solid fundamentals. Self-storage is undoubtedly not a risk-free financial decision. Just like with other asset type, there is risk. Before making a decision, potential investors should be aware of the advantages and disadvantages of the self-storage real estate sector.

The following are some of the most important benefits and drawbacks to think about:

An asset with low maintenance.

Modern technology has made it possible for owners to manage self-storage facilities with comparatively little oversight (for example, lighting and security systems). Furthermore, relatively little maintenance is necessary because each unit is essentially just a core and shell. The majority of these properties have limited landscaping and few, if any, common areas that need to be maintained. Self-storage is one of the simplest and least expensive types of real estate property to maintain over time.

An asset class with potential for stability and cash flow.

Self-storage facilities have the ability to generate reliable, regular monthly cash flow. Due to the short-term nature of the leases, it is simple for an owner to evict a tenant for failure to pay rent, and once done so, the unit can be swiftly released, which is especially true if a facility has a wait list. Since the majority of tenants are not bound by lengthy, fixed-rate leases, owners can slightly raise rents when demand rises—even by $2 to $5 per month. Cash flow can also be increased through administrative costs, late fees, and retail sales.

Potential for income stream diversification.

While the base fee for individual units will always be a self-storage operator's main source of income, those with conveniently positioned facilities can make use of their building or property to expand the range of goods and services they provide. For instance, self-storage companies with large amounts of land may provide covered but chilly outdoor storage on the extra area, which can be utilized for items that someone would typically keep in a garage or shed. Operators may also collaborate with a business like U-Haul to offer rental vehicles or vans. To diversify their sources of income and try to boost overall cash flow, owners may additionally run a gas station, janitorial service, or other industrial service at their self-storage facility.

Pro: Historically resistant to recession.

When the economy is doing well, more people move, spend money on home improvements, and shop more, all of which boost demand for self-storage. People downsize, move in with roommates, and occasionally are kicked out of their residences during economic downturns. The demand for self-storage also often rises in each of these circumstances. Self-storage has always been an asset type that is recession resistant due to its diverse demand drivers.

Financing that is inexpensive.

Due to the fact that many real estate owners also run their own self-storage facilities, financing for the purchase and any required modifications can be highly alluring. Numerous banks offer low loan-to-value, non-recourse loans. Another appealing option for owner-operators is SBA financing. A significant portion of these loans' interest-only periods help to keep costs down while the facility's owner works to stabilize it.

Short-term leases are an issue.

Self-storage leases often go from month to month. Due to the potential for significant turnover, an operator must continually market the property to enable timely release of units in the event of turnover.

Cons: There is a chance of an oversupply.

Self-storage facilities can be developed quickly and readily during periods of very strong demand because they are generally inexpensive to construct and operate. However, whenever demand declines, there may be an oversupply that drives down rentals across the board. Any potential investor should take into account both the current and anticipated (i.e., permitted) competition in close proximity to the facility they are considering to purchase.

Con: Hyper-local conditions drive demand.

Self-storage investors frequently choose a facility based on "planned" new dwelling construction, which is a typical error. For instance, a self-storage developer might enter a neighborhood carrying a sign that reads, "1,000 new housing units, coming soon!" There is no assurance that those housing units will ever be built, though. Even if pre-permitted, new development of those units could be halted by any changes in the economy. Similar to this, an operator might exaggerate demand from a nearby employer (such as a naval installation), but if that employer closes, self-storage demand might vanish over night. To protect their investment, potential investors will want to ensure that there is adequate existing demand and that this demand is varied.

Negative: Not completely hands-off.

Many individuals mistakenly believe that self-storage facilities are self-sufficient. Although there are many ways to cut operational expenses, these properties still require active management to be successful. Continuous upkeep and repairs are required to keep the building in good operational condition. Before investing in a self-storage facility, every investor will want to have a sound business strategy in place.

Does self-storage fit your needs?

Consider investing in the self-storage sector for a variety of reasons, some of which we have listed above. Self-storage is still a very dispersed asset type. Mom-and-pop business owners who are about to retire still own a lot of facilities. This presents an opportunity for anyone trying to break into the market, particularly for those who approach future operations and facility maintenance with a more professional perspective.

Self-storage is not without risk, though. This asset class has a number of subtleties that are frequently only discovered through actual experience. Anyone thinking about investing in self-storage might want to test the waters by doing so with a seasoned sponsor who can maximize returns for investors, such a Delaware Statutory Trust (DST).

Are you prepared to discover more about the possibilities for investing in self-storage? To find out how to begin, get in touch with us right away.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only and should not be relied upon to make an investment decision. All investing involves risk of loss of some, or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure:

Are There New Rules for 1031 Exchanges in 2022?

Every year, concerns about the future of 1031 exchanges surface among investors. The ability to defer capital gains through a 1031 exchange has long been a point of contention among politicians. For those wondering whether changes to this real estate investing tool have been made recently, the answer is no. Rather, interest in 1031 exchanges has grown among investors throughout the country, and new questions have emerged. Here is a glimpse at the most common questions asked by today’s curious investors.

What happens when a 1031 exchange property is sold?

A 1031 exchange allows investors to trade one investment property (“relinquished property”) for another (“replacement property”) and defer capital gains taxes they would otherwise pay at the time of sale of the relinquished property. According to the Internal Revenue Service (IRS), the two properties must be “like-kind,” which under Section 1031 of the Internal Revenue Code is defined as any property held for investment, trade, or business purposes.

What are unrealized capital gains?

When investors and real estate professionals discuss unrealized capital gains, they refer to the gains made on an asset that has not yet been sold. If capital gains are unrealized, they are not taxed. Instead, these gains exist only on paper. Only when an investor disposes of the asset must taxes on capital gains be paid. 


When can an investor use a 1031 exchange in real estate?

A 1031 exchange can be used anytime properties are exchanged as long as the properties meet the IRS’s definition of like-kind. Properties commonly traded in a 1031 exchange include commercial assets, such as apartment buildings, hotels and motels, retail assets and single-tenant retail properties, offices and industrial complexes, senior housing, farms and ranches, and vacant land. Additional trades that qualify as like-kind include investments in Delaware Statutory Trusts (DSTs) and residential properties held for investment purposes.

Can an investor avoid capital gains by buying another house?

Property owners commonly ask if they can sell their home and buy another house using a 1031 exchange. Unfortunately, the answer is no. Per the IRS, primary residences and vacation homes do not qualify for a 1031 exchange; only residential properties held for investment purposes for at least 12 months will qualify.

Can an investor take cash out of a 1031 exchange?

For capital gains to be deferred, the total value of the relinquished property must be replaced, including both an investor’s equity and debt in the property. Therefore, if an investor sells a $1 million asset and has 50% leveraged, the investor will need to purchase a replacement property for $1 million and either leverage a loan for the $500,000 or pull from personal capital. Any cash taken out from the transaction is taxable.

Exceptions to the rule, however, do exist. One exception involves investing in a DST. A Delaware Statutory Trust is a legally recognized real estate investment trust that allows investors to purchase fractional ownership interest. When exchanging into a DST, investors can determine how much they want to invest and how much debt they want the DST sponsor to assign to them. A property owner could take out cash via a sale through this investment.

How does a 1031 exchange work?

A 1031 exchange requires investors to follow a strict timeline outlined by the IRS. Missing a deadline in the 1031 process generally results in taxes due on the relinquished property.

The timeline for a 1031 exchange starts when the relinquished property closes. The property owner has 45 days to identify their replacement properties and 180 days to close. The replacement properties must meet one of three rules defined by the IRS.

Do I need an intermediary for a Section 1031 exchange?

Yes! The IRS requires that 1031 exchanges use a qualified intermediary (QI) or exchange facilitator. After the sale of the relinquished property, all proceeds are held with the QI, who will release the funds for the acquisition of the replacement properties. If funds are held with the seller or any other party that does not qualify as a QI, the sale will not qualify for a 1031 exchange, and the seller will be responsible for paying capital gains.

How does a 1031 exchange work in a seller financing situation?

While seller financing is permitted in a 1031 exchange, it is not commonly used.

Seller financing reduces the immediate capital available for an exchanger; however, this does not exempt them from IRC section 1031 that states an investor must replace the entire value of the relinquished property. Therefore, an investor must identify how they will purchase their replacement properties when offering seller-financing. The most obvious solution is to offer short-term financing. This, however, does not solve most buyers’ problems. Instead, the exchanger can work with a qualified intermediary (QI) to sell the promissory note received from the buyer to cover the funds for the exchange. The exchanger can purchase the note or sell the note to the lender or a third party. Whatever option is used, all funds need to be with the QI by the end of the 180 days to prevent the proceeds from becoming taxable. Once proceeds are available, the investor can trade into a chosen like-kind property.

Can an investor still file a 1031 exchange after closing on a property?

No, a seller cannot file a 1031 exchange after closing a property because all proceeds from the sale must be placed with a QI. Therefore, if the exchange is not preplanned, the proceeds cannot be distributed appropriately for a 1031 exchange. Investors interested in a 1031 exchange should identify a QI before selling their real estate.

Can investors avoid capital gains tax if they reinvest?

A 1031 exchange allows property owners to defer capital gains when they reinvest and follow the rules outlined by the IRS. Reinvestment gives investors access to the numerous benefits offered by a 1031 exchange, including portfolio diversification and deferment of capital gains. Additionally, reinvestment via a 1031 exchange resets the depreciation schedule on the investment, providing investors access to additional tax advantages.


What are the hottest markets for real estate investing in 2022?

The hottest market for real estate investing depends on an investor’s investment strategy. Is the investor risk-averse and looking for only stabilized assets in primary markets? Or are they willing to take on some risk for higher returns and invest in a value-add asset or a secondary or tertiary market?

To best understand which asset and market are best for you, contact a qualified 1031 exchange specialist. The team at Perch Wealth can guide you through the process and introduce you to 1031 qualified properties that are in line with your financial and investment objectives.

General Disclosure

Not an offer to buy, nor a solicitation to sell securities. Information herein is provided for information purposes only, and should not be relied upon to make an investment decision. All investing involves risk of loss of some or all principal invested. Past performance is not indicative of future results. Speak to your finance and/or tax professional prior to investing.

Securities offered through Emerson Equity LLC Member: FINRA/SIPC. Only available in states where Emerson Equity LLC is registered. Emerson Equity LLC is not affiliated with any other entities identified in this communication.

1031 Risk Disclosure: